The challenges of tax compliance in Brazil

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Clarissa Machado and Ana Carolina Utimati of Trench Rossi e Watanabe, in cooperation with Baker McKenzie, analyse Brazil’s fiendishly complex tax system and how the government is looking to simplify it.

Brazil is known for having one of the most complex tax
systems in the world. There are three levels of tax
authorities: federal, state and municipal. Although the federal
constitution and laws set forth general rules for all taxes,
each state and municipality has powers to enact their own laws
and regulations for the collection of the state and municipal
taxes, respectively.

This scenario results in more than 10 federal taxes
collected by the central government, two state taxes collected
by each of the 26 states (and one federal district) and two
municipal taxes collected by each of the 5,570
municipalities.

According to the World Bank's Doing Business report the
total tax burden in Brazil can reach 68% of a company's total
income (including profit tax, labour taxes and others).

This is not the only challenge for Brazilian taxpayers. In
fact, complying with all the other tax ancillary obligations
created by federal, state and municipal governments can be more
challenging than paying taxes. The non-compliance of tax
ancillary obligations may result in extraordinary penalties (in
certain cases, the penalties are greater than the related
taxes).

At the level of the states and municipalities, the tax
returns are usually simpler, especially considering that states
mostly collect the so-called "state VAT" (ICMS) and the
municipalities mostly collect the municipal services tax (ISS).
The other state and municipal taxes do not usually apply to day
to day transactions of legal entities, but only in specific
events (e.g., upon the sale of real estate, the municipal real
estate transfer tax should apply).

However, the real complexities in the state and municipal
taxes are the number of different compliance rules that the
taxpayer may be subject to. This is because there is no
standard ICMS or ISS tax return. Each state and municipality
may potentially create its own system, with different forms,
periods and other requirements for the declaration of such
taxes. In this context, companies that have presence in more
than one state and municipality (which is very common) must be
very cautious upon applying the different rules applicable in
each place.

Compliance with all such tax returns (i.e., ancillary
obligations) is a great challenge to companies in Brazil, which
are often required to have entire tax departments focused on
this matter or even hire specialised accounting firms to
prepare the list of tax returns applicable in each case.

According to the World Bank report mentioned above,
Brazilian companies spend an average of 2,038 hours to comply
with the tax system and tax rules, which puts Brazil in the
181st position of the 190 countries ranked by the World Bank in
the matter of paying taxes (which also encompasses other
criteria such as number of taxes and tax rates).

For reference, note that Brazil is only ahead of Nigeria,
the Republic of Congo, Guinea, Venezuela, Bolivia, the Central
African Republic, Mauritania, Chad and Somalia, while our
neighbours Mexico and Chile are in 114th and 120th place,
respectively.

In terms of the number of hours spent on compliance with the
tax rules, Brazil comes out worst, followed by Bolivia with an
average of 1,025 hours, i.e. roughly half of the hours spent by
Brazilian companies. Using Mexico and Chile as references once
more, the World Bank estimates that taxpayers in these
countries spend an average of 291 and 286 hours, respectively,
on tax compliance.

As a direct consequence, Brazil is ranked in 123rd place for
doing business around the world, while Chile is in 57th place
and Mexico is 47th.

Although not mentioned in the World Bank reports, experience
shows that Brazilian companies not only spend many hours in tax
compliance but also spend a relevant amount of money in payment
of penalties and/or endless tax litigation cases linked to tax
compliance as further discussed below.

The facts above are certainly not good signs in terms of
inviting new investment to Brazil. And under this scenario,
there has been increasing concern for the Brazilian government,
which is seeking ways to recover the economy from a very
difficult period.

From a Brazilian tax standpoint, discussions about the tax
reform are in the daily news once again. However, such
important reform – a topic in the top list of
political discussions for the last 20 years – would
demand a political investment and power that may not be within
the reach of the current government, which is in a severely
weakened position.

Meanwhile, the Ministry of Finance (Federal Revenue
Department) and the Federal Confederation of Industry are
holding a joint committee to discuss an initiative to simplify
tax compliance procedures. In August 2017, the two entities
hosted the Forum for Tax Simplification and Integration.

During this forum, representatives presented several
initiatives to integrate the three taxation levels (federal,
state and municipal), to enhance the efficiency in the tax
administration and to simplify ancillary tax obligations for
taxpayers.

Also during the forum, the Chief of the Federal Revenue
Department presented four measures for the simplification of
the tax system, with primary goals of reducing the costs to
companies, making the business environment in the country
better, and ultimately increasing the competitive capacity and
production. These measures may be summarised as follows:

The first measure: In 2007, the
federal government created the Public System of Digital
Bookkeeping (SPED), a platform that unifies the presentation
and retention of tax and accounting information. In this
context, the first measure is to enlarge the reach of the
system, allowing different levels of tax authorities to access
and share information using this system.

The second measure: This deals with
the simplification of the tax ancillary obligations with the
states. The objective is to eliminate the requirement to
present the same information twice in SPED and in the state tax
returns. According to the Federal Revenue Department, this is
because approximately 87% of information requested in state
returns is already reported in SPED.

In accordance with this project, the taxpayer
would present all relevant information for state taxes within
SPED and the state tax authorities would have access to such
information without the necessity of another specific state
return.

There are reports of a pilot of this project
in the states of Goias, Alagoas and Mato Grosso, with the
objective of having all states using SPED for state purposes
within six months. In a certain way, it may be viewed as a new
mechanism for automatic exchange of information between the
states and the federal government, but with a fair goal of
simplifying ancillary obligations and mitigating the risk of
mismatch of information.

The third measure: This measure
deals with the municipalities. As previously mentioned, each
municipality is currently allowed to create its own system to
control municipal taxes, such as the municipal services tax.
Accordingly, several municipalities created systems for the
issuance of electronic invoices. In this scenario, the third
measure to simplify the tax system aims at defining a national
standard electronic services invoice and creating a data basis
to control the electronic invoices issued.

For this project, São Paulo, Brasilia,
Belo Horizonte, Rio de Janeiro and other four cities are
testing the pilot, which should be implemented nationally by
the end of the year.

The fourth measure: The objective of
this measure is to simplify the customs procedures for
importation and exportation of goods. This project has two
phases. The first is the creation of a joint federal and state
system to control the payment of federal and state taxes upon
importation. Currently, only the federal taxes are controlled
electronically by the foreign exchange system and the taxpayer
has to carry out the payment of state taxes separately.
According to the Federal Revenue Department, this project would
reduce the time to import in 41% and the time to export in
38%.

The pilot project is scheduled to start in
São Paulo, Rio de Janeiro and Pernambuco at the end of
the year, but the application for the rest of the country is
still not defined.

The second phase is to create a 'customs
clearance on water', which would allow certain companies
(authorised economic operators) to have their goods cleared
from customs even before arriving in Brazil. The system is
still in development for this phase, thus this phase is not
expected to be in place until 2018.

The fact that the Ministry of Finance and the Confederation
of Industries held the forum is a clear indication that the
burden of tax compliance in Brazil is a problem widely
acknowledged not only by taxpayers but also by the authorities.
Besides, the projects presented at the forum seem to address
some of the problems with tax compliance in Brazil. However, we
will only be able to truly affirm that such projects will be
effective in simplifying the tax system after they are fully
operating.

If you fail

The compliance with tax ancillary obligations in Brazil is
not simple, which makes Brazil one of the least inviting
countries in which to do business in the world. However, if
complying with the tax system is burdensome, not to do so is
even worse, considering the penalties that can applied by
federal, state and municipal tax authorities. Different
relevant penalties may apply in case a company lacks compliance
with tax obligations, even in the case it has adopted
– in good faith – a different interpretation
of the rules in place.

At the federal level, the standard penalty for lack of
payment of taxes is 75% and can easily be increased to 115%,
150% or 225%, if the tax authorities conclude that there is any
evidence of fraud or lack of cooperation of the taxpayer with
the investigation.

Specifically in connection with ancillary obligations, the
presentation of tax returns with incorrect information can
result in penalties of up to 3% of the total amount of the
commercial and financial transactions of the taxpayer.

In the state of São Paulo, the standard penalty for
lack of tax payment is 80% of the unpaid taxes, and penalties
for the non-compliance with tax ancillary obligations can reach
up to 50% of the amount of the transactions.

In the municipality of São Paulo, the penalties for
the lack of payment of taxes and for the lack of compliance
with ancillary obligations are 50% of each tax due.

Although it may be difficult to comply with all tax
obligations in Brazil, this means that the company should put
relevant efforts to do its best and accordingly to try to
mitigate the risks of assessment for lack of compliance.

We believe that if the measures described above are
seriously implemented, there will be a relevant improvement in
the tax system as a whole, and both taxpayers and authorities
will win.

Clarissa Giannetti Machado has extensive experience
advising clients on tax planning. Partner since 2007,
she has worked in Baker McKenzie Chicago office in 2002
and in Baker McKenzie Amsterdam office in 2006.
Clarissa has co-written articles on tax issues for
several publications. She has been nominated as a
leading tax lawyer by Chambers Latin America (since
2010) and as a pre-eminent figure in global transfer
pricing deals by Euromoney's Guide to the World's
Leading Transfer Pricing Advisers. Clarissa advises
companies with business operations in Brazil on
transfer pricing, real estate transactions and general
tax planning. She helps clients develop and implement
tax-efficient structures for financial transactions,
acquisitions and sales of business operations, real
estate operations and related transactions. She also
counsels clients on the economic valuation of Brazilian
companies. Clarissa graduated in 1997 from the Law
School of the University of São Paulo and in
business administration from Fundação
Getúlio Vargas. She gained a master of laws
(LL.M.) in 2002 from Columbia University School of Law
of New York and was admitted to practice law in the
State of New York (approved by the New York Bar in
2002).

Ana Carolina Utimati joined the firm in 2003 and
became partner in 2015. Her practice includes
administrative law, tax consultancy and tax litigation.
She is an expert in tax administrative proceedings,
experienced in drafting defences, appeals and requests
for rulings with sectors of the federal, state and
municipal tax public administration, as well as with
social security sectors. She graduated in 2002 from the
Law School of the University of São Paulo.